Sri Lanka has achieved much in fiscal management - Dr. P.B. Jayasundera

The government can take the credit for better fiscal management having lowered fiscal deficit towards 6.4 percent of GDP in 2012, said Treasury Secretary Dr P.B. Jayasundera at the 14th Sri Lanka Economic Summit 'Re-balancing Sri Lankan Economy' organised by the Ceylon Chamber of Commerce in Colombo.

He said that it is confusing on which benchmark re-balancing has to be done, especially in fiscal management.

Following are extracts of his speech.

If the benchmark is the post 1977 economy, we have made significant achievements in the recent past. Fiscal and Balance of Payments were in much large deficits of around 19 percent and 16 percent of GDP in the early 1980s, then again over 12 percent and 7 percent of GDP in the late 1980s.

During the late 1980s and throughout 1990s in particular, the economy went through structural reforms in many areas covering trade and payment arrangements, liberalisation of the exchange rate regime. As we all know, the country has gone through a number of IMF and the World Bank supported stabilisation and structural reform programs, although in most instances the full program could not be completed.

Even throughout these periods, the average fiscal deficit remained over 8 percent of GDP and the Debt to GDP ratio touched 105 percent. External deficits were large and the exchange rates were unstable, while depreciating continuously. Export to GDP and Tax to GDP deteriorated from 29 percent and 20 percent in 1980 to 17 percent and 14 percent in 2005.

Unemployment, inflation and poverty ratios were double digit. Regional and income distribution remained stubbornly high. These indicators that show that there has been no good balance in comparison to corresponding trend indicators of the past seven years.

The 2009-11 Standby Arrangement was the only program that completed the full cycle, having satisfied all program targets. If so, to what level and against which benchmark do we re-balance now? he queried.

Changes in fiscal management after 2005

Traditional poverty reduction strategies in Sri Lanka were heavily influenced by the distribution of handouts and cash transfers. However, the present government has reoriented these strategies through the provision of basic rural infrastructure, improvements in public service delivery mechanism and livelihood development initiatives to create gainful income generating opportunities.

The annual budget has accommodated such expenditure while protecting cash transfers to vulnerable groups. The recent initiatives to convert cash transfers to low income groups through the issuance of stamps to be en-cashed against commodities at Co-operative system to direct transfers to their saving accounts enables low income families to build investable funds.

Community centric approach now being pursued keeping in line with long standing working arrangements in the rural agrarian economy in Sri Lanka with expanded micro finance arrangements by the government and the private sector have gathered momentum in rural development.

Fiscal reforms

The sustained reduction in poverty levels in recent years to around 6.5 percent with the reduction in dispersion to a range of 2.4 to 7.5 percent between rural, urban and plantation sectors must be viewed along with these changes and improvement in rural livelihood activities.

Fiscal reforms which is at the center of the reform matrix in the context of stable public investment levels has not only addressed deficit reduction through moderation of current expenditure which is supported by a gradual reduction in defence expenditure, but has also implemented long over due tax reforms to move away from relying on liberal tax concessions and has restored a regionally competitive rate structure with a wide tax base.

Concessions

The initial phase is costly to the extent that it involves revenue losses and is also confronted with other challenges such as the erosion in the import base, has resulted in weakening the buoyancy in the traditional excise tax and caused transitional challenges in administering taxation in an emerging service economy.

However, the concessions having being explicitly incorporated in Income Tax Laws, the introduction of the Strategic Investment Law to govern large investments, institutionalising the Tax Appeal Commission and Tax Interpretation Committee along with the transition towards an IT based tax administration by the end of 2014 and a further rationalisation of exemptions in the various tax statutes, the country should see a progressive improvement in tax to GDP ratio.

The compliance improvements and strict enforcement of tax laws, the further consolidation of retail level VAT introduced this year and the private sector moving away from relying on tax concessions, as has been the traditional practice through the BOI in the past which made a narrow tax base, are essential steps in this reform process.

Adjustments

As shown in the first half year data, income and VAT sources from domestic activities have taken an upturn while import base indirect taxes have continued to suffer as imports of largely motor vehicles haven't returned to stable levels yet.

There is a trade off between government revenue and imports. However, the government has refrained from introducing ad hoc measures to balance this trade off as it is expected to be statistical and a short term phenomena.

Nevertheless, the Finance Ministry is confident that there will be improvements in the second half of this year over the contraction witnessed during the second half of last year, together with continued moderation in recurrent expenditure, the deficit set for this year at 5.8 percent is realisable.

The Government remains committed to see that the deficit reduction path seen in the post terrorism period is continued to reach further progress in 2014 and 2015 to bring the deficit to below 5 percent which seems to be consistent in accommodating available long term financing at relatively low rates from foreign development partners and domestic sources while creating increased space for private borrowing.

Economic growth

This level of deficits over the 2013-15 medium term fiscal framework within which the government formulates its fiscal strategy is conducive to provide greater freedom to the Central Bank to conduct its monetary policy towards a mid single digit inflation.

The analytical work undertaken by the Department of Fiscal Policy also indicates that an economic growth in excess of 6 percent with a fiscal deficit reduction towards 5 percent from the current level is conducive to bring the debt to GDP level down to 70 percent by 2015 and to below 60 percent by 2020.

The Government's fiscal strategy also aims at reducing loss in state owned business enterprises.

As the Finance Ministry in its 2012 Annual Report has shown, Sri Lanka has 54 State Owned Business Enterprises of which 10 own an asset base well in excess of market capitalisation of all listed companies in the country.

They include state enterprises such as Ceylon Petroleum Corporation, Ceylon Electricity Board, Sri Lanka Port Authority, Airport Authority, Water Supply and Drainage Board, Sri Lankan Airlines, the three large state banks and Sri Lanka Insurance.

Let me now turn to spell out the road we need to travel together to consolidate the gains so far reaped and accelerate our development while managing the fiscal deficit reduction path and their vulnerabilities to secure further stability.

Let us first try to quantify the planned deficit reduction towards 4 percent by 2015. In fact that was the deficit Sri Lanka seemed to have maintained in 1950. Given that the 2013 deficit target of 5.8 percent remains a firm commitment of the Government to ensure a continuity for the fourth year in such a downward direction is noted, we need a further 2 percentage points or about a Rs. 250 billion reduction over the next two years in our efforts to raise revenue or allow recurrent expenditure growth to moderate by that amount or a combination of both.

Since feasibility improves with a proper distribution between revenue and current expenditure the adjustments appear manageable due to several reasons.

Intensified tax audits

First, the effects of the moratorium on tax holiday extensions should bring the remaining 40 percent out of 1,962 commercially functional BOI enterprises at the end of 2012 to the tax system over the next 2-3 years that is of about 330 commercial operations. Second, full operations of VAT at retail level commenced this year with a further rationalisation of the exemptions list together with intensified tax audits of 13 large and corporate tax payers including SVAT arrangement now in place to simplify the application of VAT to zero rated category should improve tax elasticity of the VAT system.

Third, the normalisation of imports following the sharp adjustments made to bring imports in line with normal trends should reflect recovery in revenue collected at the point of imports though applicable taxes which have been simplified recently depending on the purpose for such taxes and administrative convenience.

Out of about 6,000 line items, 179 items remain free of any tax and 570 are subject to only a Special Commodity Levy (SCL) due to the nature of such imports and easy administration for both importers and tax administration.

Tourism

A further 425 high value branded products are liable only to the Port Levy and Nation Building Tax. They remain a buoyant source of revenue in the background of the expansion of tourism and high income growth effects of such commodities in the domestic economy.

According to our classification, only 2,033 items are liable to PAL, NBT and VAT while 1,811 line items are liable to the Port Levy, NBT, VAT, Excise taxation and Customs duties.

Only 3,628 line items come under import duties as Free Trade and other simplifications made to Customs tariffs have reduced the reliance on Customs duties. Since we have a four band tariff structure of 0, 5, 15 and 30 percent we may need further rationalisation of customs tariffs having regard to keep exports free of taxes, maintain local industry safeguards and in view of revenue considerations.

All concessional import facilities on motor vehicles extended to public servants are also subject to taxes ranging from 20 percent to 100 percent and no one is exempted from PAL, NBT and VAT, bringing them to a minimum 20 percent.

Investments approved under the Strategic Investment Law are subject these three taxes and Customs duty from the day they come to commercial operation. These are substantial improvements over the past tax regimes which allowed unlimited concessions at the cost of government revenue.

Fourth, the Government has also rationalised land and property taxes to improve the value of land use for foreign and domestic land transfer transactions.

Profit and Income tax for exports, tourism, constructions, SMEs and agriculture has been reduced to 12 percent and the rest to 28 percent justifying the redundancy of tax holidays anymore.

Wage income and interest income have been subjected to tax at source and compliance is expected from employers and banking and financial institutions in the private and the public sectors as public sector too has been brought under taxation for the first time after 1978.

So the responsibility of the private sector is to protect the low rate and wide base tax regime, through better compliance.

Taxation of income from other sources and from income of professional service providers remain to be a challenge but considering the fact the average tax rate has been reduced to about 17 percent and professionals are expected to adhere to best practices and professional ethics.

This source would become an elastic revenue over the medium term when the country begins to see a rapid expansion in this sector. Tax administrative reforms are being directed to improve compliance and enforcement as well.

Pricing policy

The government's revenue efforts are also being made through improvements in profits and dividends in State Owned Business Enterprises in addition to applicable income taxes to raise non tax revenue of the Government.

Towards this end, the importance of adopting a cost reflective flexible pricing policy has been recognised instead of rigidly administered pricing arrangements for key state owned business enterprises, capitalisation and balance sheet restructuring to place them on a commercial footing, engagement of competent managerial staff and the adoption of modern procurement and financing practices are in progress.

The SOBEs are also encouraged to move away from their reliance on the national budget for capital investments and financing of operational losses. This will enable financial institutions and rating agencies to interact with SOBEs on the basis of doing business more on commercial considerations rather than on Treasury protection.

However, these changes take time as they are essentially of a structural nature involving legal, administrative and political challenges but progress so far is encouraging, he said.